Liquidity, both physical and financial, tends to take the path of least resistance.
If it is easy for corporations to borrow in public debt markets because high liquidity keeps interest rates low (in the near term), corporations that lack ideas for organic expansion at high ROI will issue debt and use the proceeds to buy back equity or go on M&A sprees. Those purchases raise the price of equities regardless of underlying fundamentals.
If it is easy to borrow from a bank or in public debt markets to buy a residence for occupancy or investment (see, e.g. Blackstone’s residential investment fund http://www.blackstone.com/businesses/aam/real-estate), consumers and investors will borrow and push up house prices. There is evidence from the structured finance industry that the market that has been least resistant to secondary financing has been the auto loan ABS market, especially in sub prime loans. It’s no surprise, then, that auto prices have held up better than home prices as borrowers find easier access to auto credit than mortgage loan credit.
Finally, the least resistant path for liquidity may be in the art world as wealthy investors need to “do something” with their cash that is earning next to nothing in the fixed income market. Doing nothing can be very difficult.
In the year from July 2013, sales of contemporary art at public auctions reached $2.046 billion dollars, up 40 percent on the previous year, Artprice’s annual report said.
Howard Marks has a great maxim for this behavior:
What the wise man does in the beginning, the fool does in the end.
We are in unchartered territory with respect to Quantitative Easing, but as Herb Stein has said, “If something cannot go on forever, it will stop.” The Fed will have to stop providing liquidity eventually. When the Fed stops, many will be caught by surprise and they will suffer. Don’t be one of those people.
Please help me understand how the art market relates to QE. Low rates on fixed income make investors want to buy expensive art? Where is the proof of that? Are you saying people are buying art at auctions to bid it up higher at another auction? Like a momentum stock that keeps going higher and higher despite a low intrinsic value, like Tulipmania?
QE and ZIRP flooded the markets with cash that had to go somewhere. Most of it ended up in the hands of people who have the ability to borrow and spend at low rates. Companies issued debt at low rates to buy back their stock and buy other businesses and the corporate executives who get paid mostly in stock (options, etc.) are the beneficiaries. So, a significant amount of QE and ZIRP got into the hands of people who are likely to bid up the prices of things like art. QE and ZIRP first found its way into the stock market. Those options paid for art and other luxury items.